Analysis-Euro, now a safer bet, emerges victorious from market turmoil By Reuters

By Sruthi Shankar and Alun John

(Reuters) – The euro is trading at its highest level this year against the dollar, emerging as a clear winner from recent crises in global currency markets that have destabilized a strong dollar and halted a relentless slide in the Japanese yen.

After decisively breaking above the symbolic $1.10 level, the euro’s more than 2.5% gain in August sets the currency up for its best month since November.

Traders, so far distracted by the yen’s surge after a surprise July 31 interest rate hike by the Bank of Japan and a sharp rally in the dollar as expectations for a US rate cut grow, are taking note.

After all, history shows that $1.10 is not an easy level to break, and as recently as April, some analysts speculated that the euro could weaken to parity. It is now the second best performing major currency against the dollar this year, after the British pound.

Gains, expected to be modest from here, are nevertheless notable as talk of a US Federal Reserve interest rate cut coincides with speculation that further easing by the European Central Bank could be limited by stuck services sector inflation.

“It’s a rate differential story,” said Commerzbank (ETR: ) currency analyst Volkmar Baur.

“Inflation is falling on both sides (of the Atlantic), but the Fed is expected to move a little more aggressively lower, and that closes rate spreads a bit and gives way to a stronger euro.”

The ECB, which cut rates in June, could offer at least two more 25 basis point cuts, market prices suggest.

Instead, traders see 94 bps Fed cuts in the three remaining meetings this year — involving three 25 bps moves, with a high chance of one more. That’s a change of about 30 bps since early August; ECB prices moved much less.

That shift followed weak data from the US labor market, which raised recession fears and rattled stocks and bonds. Markets have since calmed, but expectations of policy easing remain.

Certainly, not only did the euro strengthen against the dollar in August, but the single currency is where there are least complications for traders looking for a relatively safe FX bet.

The yen is volatile after the end of a massive carry trade. Sterling gained less in August after a UK interest rate cut and French political risks, which weighed on the euro in June, eased.

“We have seen some risks removed from the euro, such as the French election,” said Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International.

“Now it becomes a cleaner central bank story.”

BECAME GROSS

From here, however, the euro may struggle to make further progress.

It is at the top of recent trading ranges and there is less scope for rate differentials to shift further in its favor, analysts said.

Commerzbank sees the euro at $1.11 by the end of the year, unchanged from current levels. ING sees it at $1.12 in a month before falling to $1.10, and BofA expects $1.12 by the end of the year.

“My view in the second quarter of 2023 was to play the trading range. You buy the euro at $1.05 and sell when it moves above $1.10,” said Mathieu Savary, chief European investment strategist at BCA Research.

For some, that might even be for the winnings.

“These are the strongest levels for the euro you should expect between now and the end of the year,” said Guy Stear, head of developed markets strategy at Amundi Investment Institute, who believes the case for further ECB cuts has been more compelling than for the Fed.

A recent economic recovery in the euro zone is showing signs of slowing, while a gauge of German investor sentiment posted its sharpest decline in two years in August.

Instead, the next round of US jobs data could show that July’s lackluster report was just a Beryl-led hurricane.

Another factor complicating this mix is ​​the US presidential election on November 5.

While there are many moving parts, analysts said Republican nominee Donald Trump’s policies of higher tariffs and lower taxes would likely cause higher inflation, which means tighter Fed policy and a stronger dollar.

Rabobank’s head of currency strategy, Jane Foley, noted that the euro’s recent surge came as her Democratic rival, US Vice President Kamala Harris, gained in opinion polls.

“What could really push EUR/USD above $1.10 and sustain that is a Harris win and a US slowdown,” she said.